Understanding volatile propane prices

October 1, 2003 By    

Propane prices, like most energy commodities, continue to experience extreme
volatility. There are a number of factors impacting propane prices during the
year. The major variables we watch include weather, crude prices, natural gas
prices, refinery and gas plant production, net imports, petrochemical demand,
and overall propane inventory levels. Let’s take a look at each of these fundamentals.

About 60 percent of propane demand in the United States occurs in the October
to March time period. Weather during the winter season drives propane demand
for home heating, temporary space heating, gas logs, agricultural and commercial
heating. The 30-year norm for heating degrees days in the United States is 3,962.
Six of the last 10 winters have been warmer than normal and have impacted overall
demand greatly.

About 51 percent of the propane produced in the U.S. comes from the refinery
process and about 49 percent from gas plant processing. Therefore, propane prices
are impacted by fluctuations in crude and natural gas prices. Over time, propane
has tracked crude oil as you can see in chart 1, above.

Normally propane is about 75 percent of crude on a pricing relationship but
this can vary significantly based on supply/demand and inventories. Winter spikes
of 130 percent can occur or it can be as low as 60 percent in the summer period.

With the advent of a normal winter last year and with inventories in all energy
products below normal levels at the end of the winter season, natural gas has
driven propane prices this summer. In fact, natural gas has been about $2 mm
btu higher than normal during the summer months. See chart of natural gas prices
in chart 2, below.

Natural gas prices
From a supply standpoint, gas plants and refineries produce about 1.1 million
barrels per day (bpd) of propane to meet U.S. demand of 1.3 million bpd. The
remaining 150,000-200,000 bpd comes from net propane imports. Canada is the
largest importer to the United States by pipeline and rail car, sending about
150,000 bpd. Waterborne imports account for the remainder of supply offset by
exports from Mt. Belvieu to Mexico and Latin America. Overall, net imports are
about 150,000 bpd. Exports in 2002 were at record levels totaling 66,000 bpd
and helped to provide a total inventory draw of 50.5 million barrels this past
winter.

When the economy is robust, the petrochemical industry is normally the largest
domestic consumer of propane. About 75 percent of the U.S. petrochemical industry has flexible cracking and can switch feedstocks based on finished product demand and economics of these feedstocks. Petrochemical processors crack multiple feedstocks such as ethane, propane, butane and naptha to make ethylene, the feedstock for the plastics industry.

In recent years, the petrochemical industry has cracked a high of 420,000 bpd
of propane and can go as low as 180-200,000 bpd. This swing can have a major
impact on propane inventories.

Petrochemical demand
Historically, propane stocks build during the summer months for the upcoming
winter season. Stocks end the winter at 20-25 million barrels and then build
during the April to September time period. In the past, we have felt comfortable
with inventories of 60-65 million barrels by Oct. 1. We then draw 40 million
to 45 million barrels in a normal year (see chart 3, above).

Last year we had record exports and actually drew 50.5 million barrels over
the winter period as shown in the chart below. We exited the winter at 19.5
million barrels, which is extremely low. Warm winters have tended to mask demand, so many feel inventories need to build to 65-70 million barrels by Oct. 1 for the winter season in the future.

In summary, there are a number of variables that impact propane supply/ demand
and ultimately pricing for this commodity. One has to look at all these variables
as the year plays out. There are a number of tools such as storage, pre-buys,
call options, collars, and swaps that can be utilized to manage this volatility.

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